Recession and Creative Destruction

Recessions should be seen as periods of creative destruction. The system has become over-heated and fundamental flaws have appeared. But these failings will spawn innovation – or the process of creative destruction – tearing down what is defective and finding new ways through. The innovative opportunities that creative destruction presents should be seen as the “silver lining” of a recession.

Whilst new opportunities will appear, there are real chances that your business may now be caught in a vice-like grip. Your target markets may be permanently disappearing and the needs of long-established customers could be fundamentally changing.

This could well place your business in a destructive vice-like grip. On one side you have the pressures of declining revenues and profit margins – on the other side you are faced with the need to totally rethink your strategy and business model. But you must break out of the vice to be able to take advantage of the positive side of creative destruction.

But how do you break out?

What do you do first?

Will traditional strategy making methods work? How long will it take? What are risks?

These are just some of the questions probably spinning around in your mind.

To help you, this article looks at research that I conducted during the last downturn within firms that were being squeezed tight in the vice. Some made it through and built the capacity to reap benefits from new waves of creative destruction. Others failed and were dragged down.

In this briefing I will tease out what separated the winners from the failures.

In the grip of recession

During the early 1990s, the UK was in the grip of an economic downturn and a heady combination of recession, new entrants and technology threatened the traditional business models of a group of companies that I researched.

Profits had been hit badly. Balance sheets were haemorrhaging capital. In some cases corporate life expectancy could be measured in months, not years.

These organisations were in a the grip of the paralysing vice.

On one side revenues were falling and profit levels were plummeting. But on the opposing side of the vice pressure came in the form of failing business strategies, strategies that were just not good enough to cope with the tactics of new entrants and changing markets structures.

I wanted to find out, in this most challenging of situations, what corporate leaders really did. Would traditional approaches to strategy making and change management work? Or would another approach be needed? And if another approach was needed, did this demand special leadership qualities?
But what to do first?

This was the initial question that the corporate leaders that I studied had to answer.

Interestingly, the successful companies – those that went on to permanently turnaround their businesses and innovate their way out of a crisis, answered this very first question in a totally different way to the failures – those that didn’t build a new capability to take advantage of the innovation opportunities that creative destruction would present.

If we start by looking at the failures, their answer to this first question was entirely logical and follows what we have learnt in strategy courses at business school.

The priority of the failures at this point was to figure out a new strategy. Time and effort was invested by the top management team in reviewing strategy and planning a new way ahead. This plan would effectively provide the blueprint for all new activity over the coming years.

This is the approach that is instilled into all managers. Faced with a problem we stop, analyse, plan and implement. A sequenced process that has been around since the early decades of management as a science in the 20th century.

And initially this approach seemed to work, at least in the short-term. Profits were stabilised. There were some small innovation successes too. The failures pulled ahead. But then things went wrong for them.

So what did the leaders of those companies that were to ultimately succeed do that was different?

A general rule

At the highest level, there were three major distinguishing characteristics that separated leaders of the successful from the unsuccessful:

Characteristic #1: Explore, don’t strategise. Successful leaders were very good at routing out problems in their organisations. Problem identification, particularly in the early stages of the change process, was a key priority. Strategising – developing a new medium or long-term strategy – was way down their list of priorities. Problem identification and building an organization that could experiment and learn were far higher up on the list of priorities.

Characteristic #2: Change leadership style to match the situation. The process of large-scale change isn’t just one process. As we will see below, the successful leaders generally broke the process of large-scale organizational change into three major phases or episodes. And for each phase they adopted a dramatically different management or leadership style.

Characteristic #3: Change is not a linear process. Unlike many day to day management issues and tasks, large-scale change and reorientation is not a rational stage by stage process. It has a tendency to be an irrational process. The organization can oscillate backwards and forwards between the different phases of the change process until change is fully embedded. Some researchers call this oscillating process “organizational schizophrenia”. Again, successful leaders seemed to take this in their stride and had a good grip on exactly where their organizations were in the change process. Interestingly, leaders of the failed organizations seemed to regard the change process as strictly a linear one.

As we have introduced, the successful leaders took, at the highest level, their organisations through three phases of change that we will now explore.

Phase #1: Stabilising the Patient

This first phase, has three major focal points:

(I) Financial Stability – stopping the capital haemorrhage.

(II) Locating Barriers to Change.

(III) Challenging Culture.

We mentioned earlier that a key quality of the successful change leader is to be able to match style to situation. In this first phase, leaders adopted very much a strongly directive, interventionalist, management style.

An essential first step is to ensure that all members of the top management team are fully aligned around the need for exploration and change.

Rapid changes were made to ensure that this was the case. Failure to rapidly align the management team would only throw up real problems later in the change process.

In parallel, there was the need to find out where the organization was making and losing money – to stop the outflow of capital. Structural changes were made to ensure that clear responsibility and accountability existed and significant effort was invested to ensure that the right systems were put in place to monitor the process of financial recovery. In short, the priority was to ensure that:

(a) The organization knew which customers and products were losing money.

(b) The profit making customers and products were identified and protected.

(c) Clear lines of accountability for customers and products existed.

(d) Top management knew precisely who could take key decisions in customer and product markets.

(e) The right performance management information was being produced to track financial recovery and quality of decision making.

On top of these actions, there was one other critical activity in this first phase and that was to start the process of challenging the old culture and instilling the need for change. Communication excellence was the tool commonly used to start the process of cultural change. Communication initiatives, aimed particularly at the customer facing staff, were put in place to ensure that everyone appreciated the gravity of the situation and was galvanised by a sense of urgency. Importantly, communication initiatives to start the process of cultural change were led personally by the corporate leader.

Key actions and outcomes can be summarised as follows:

Phase #2: Exploring

Whilst the patient has been stabilised, possibly surprisingly, it is still not time to think about long-term strategy.

Now is the time to focus on:

(I) Exploration: Finding out what is really happening in the new, emerging competitive environment.

(II) Development: In mature, established organisations, internally focused process and system based skills tend to predominate. Now is the time to start build externally focused competences that can help the organisation to explore the outside world and create the knowledge and experience that it needs to build a new strategy.

In this second phase, the focus shifts to learning and experimentation.

Finding out what does and doesn’t work in the new outside world.

This is a time to be tolerant of failure. Many of the most successful organisations in my study initially failed in their attempts to re-connect with the outside world. But they excelled in analysing why these attempts failed. And it was from this analysis of failure that enduring success was born.

In this phase the leadership style materially changes and in many respects is opposite to the highly directive style that we saw in the first phase. In this second phase we see a style that one leader described as “forging and supportive”. This is a time to focus on “softer” issues such as competency and staff development. However, from time to time it is necessary to return to the more interventionalist approaches of phase #1. As introduced earlier, change does not follow in a rational straight line. Typically, in this second phase, expect to discover more barriers – especially within middle management and functions that were responsible for the organization’s success in the distant past. So, expect some oscillation or “organizational schizophrenia” at this time.
Key aspects of the Exploring phase are summarised below:

Phase #3: Crafting

It is only now, possibly some 24 to 48 months after the change process started, that the organization gives real attention to crafting long-term strategy.

This is in sharp contrast to the approaches taken by failing organizations. They jumped in straight from the start to create new strategies – blueprints for long-term action.

Leaders of the successful organizations realised that this wouldn’t work.

There are several very simple reasons why any attempt to build a new long-term strategy at any earlier point would fail. At any earlier time, the organization would not have had the experience, views, information, culture, systems and structure to build anything that was radically different, something that constructively responded to the opportunities presented by recession’s creative destruction.

The three key priorities in the third and last phase, Crafting, are:

(I) Long-term strategy creation.

(II) Empowering staff, especially customer facing staff, to take more responsibility designing how they inter-act with their customers.

(III) Embedding the learning.

Conclusions: Implications for today

So, what has this research, conducted during a past recession, got to do with the position that we’re in now?

Well, there are these pointers:

#1: Don’t think about big, long-term changes to your mission and strategy right now. Resist, from the perspective of long-term strategy making, the urge to “analyse – plan – implement” that we saw above amongst the failed organizations. The reality is that currently, we know too little about what the new world will look like.

#2: Do however ensure that your management team is 100% behind the need for change and particularly values and supports the need to explore. Look for barriers too that will get in the way of exploration.

#3: Do ensure that your performance management information is up to scratch. You really must have a clear view of which customers are making money and where losses are being made. Monitoring changing needs and behaviours amongst your key profit making customers will be a key activity. Some of the questions that you will wish to answer are “Will our key customers be with us for the long-term?” “Will their needs change permanently?” “If our key customers are going to disappear – who will replace them?” Answering these questions through exploration will help you to determine how the waves of creative destruction will impact your organization’s strategy.

#4: Decision controls. In a fast moving environment, make sure that the right people with the right knowledge are making the key profit and loss account decisions. This will entail understanding how decisions are made right at the customer facing edge of the organization.

#5: Do set up projects and experiments to explore the outside world, but make sure that the downside, if things go wrong, is controlled. Start by changing in just small ways how the organization inter-acts with its customers.

#6: Analyse the results of the experiments carefully. Even the failed experiments will contain golden nuggets of experience that will point to how your organisation can take advantage of the opportunities that creative destruction will bring us.